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Apple’s hardware “dilemma”

It has become a routine: rumors and speculations lead up to an Apple event wherein the company introduces products that “fail expectations” but go on to sell out and make huge profits. But why does this happen like clockwork, year after year?

To be sure, part of it comes from market speculators who make money from AAPL price swings, but the inability or unwillingness of analysts and pundits to understand how Apple works is the more likely reason.

The “failure” is declared by comparing Apple’s hardware specs against those of its competitors. Like “covering” a U.S. President through the confines of the White House press briefing room, hardware specs are the lazy person’s ideal tool: short, simple, often numerical, but ultimately not very illuminating.

One of the key ingredients of Apple’s spectacular success over the last decade has been the inability of its rivals to distinguish hardware from product. As the proverbial design adage goes, “People don’t want to buy a quarter-inch drill. They want a quarter-inch hole.” Non-geeks, Apple’s primary audience, aren’t interested in what the hardware is, but how the product solves their specific problems. Hence they buy on demonstrable value, rather than on potential of hardware specs.

But Apple detractors ask why should the most valuable technology company on the planet — with a large patent portfolio, unrivaled in-house industrial design capabilities and enormous influence over its supply chain and component pricing — fail to offer the best hardware specs in the industry for its premium products? There are a few basic reasons why Apple doesn’t believe it’s in a hardware race.

Hit or miss, no surprises here

Like Hollywood, Apple is perceived to run a hit-driven business. Perhaps the single most important question affecting AAPL’s P/E compression is whether Apple can continue to generate blockbuster products with regularity, especially in its most profitable iOS line.

This requires a sufficient degree of surprise of the “One more thing…” variety and the secrecy that secures it. However, it’s a monumental task for Apple to coordinate the sourcing and assembly of countless parts for its iOS and Mac devices from three continents in total secrecy so that it can spring on its loyal users products to buy at specific annual intervals. No wonder Tim Cook recently said Apple is going to “double down on secrecy.”

While surprise has been essential to Apple’s success, total secrecy may no longer be attainable or even necessary.

From Retina displays to DRAM chips to CPUs, Apple’s principal component supplier for iOS devices is Samsung, accounting for about a quarter of the component cost of an iPhone. To add insult to injury, Samsung is also Apple’s biggest rival in consumer electronics and one that takes particular delight in aping every aspect of its products down to icons. Furthermore, as various investigations and court cases reveal, many people in Apple’s vast supply chain are fond of divulging its upcoming product secrets in exchange for money from stock manipulators and rivals. One way or another, rumors, tips, “supply chain checks” and “sources in Asia” turn into a steady stream of “Confirmed!” headlines that then precondition us to discount the significance of Apple’s offerings when they do in fact materialize.

Lately, it’s become very difficult for Apple to surprise us with breakthrough hardware. As a matter of fact, since the introduction of the iPhone, Apple gave us precious few surprising breakthroughs in hardware. To an average user, the differences between consecutive iPhone versions, from 3G to 4S, are purely incremental improvements or aesthetic embellishments, not hardware breakthroughs. Sure, better cameras, higher resolution screens, cases that feel richer to the touch, faster speeds…but no significant surprises or breakthroughs in hardware. In hardware terms, the iPad is indeed not much more than a large iPod touch. And yes, days before their likely introduction, we know and certainly expect Retina-like displays on upcoming Macs. They’ll surely be great, but hardly surprising hardware breakthroughs.

Lots of new technologies not yet in iOS products have already been deployed by an army of Apple rivals: larger phone screens, NFC, haptic displays, stylus, inductive charging, very high-resolution cameras and so on. So we couldn’t count their appearance on upcoming Apple products as surprising or hardware breakthroughs either.

We could certainly see in an upcoming iOS device some unforeseen application of Liquid Metal or a novel 3D camera setup or flawless bio-metric security or a one-week battery or a silky smooth digital pen with zero perceptible latency or wireless power transmission or bendable screens…We could, but we likely won’t any time soon.

Apple knows how to count SKUs

There are certain characteristics of Apple that put it in a different category than any other hardware manufacturer. Unlike others, Apple carries an extremely small number of products in each category, with minor and easily discernible differences. There’s really only one iPhone and one iPad. There are no pro, lite, region-specific or one-off versions. Samsung can introduce a phablet with a stylus. When it fails, not a big deal, Samsung has dozens of other models. Motorola can try a smartphone that forms the brains of a larger computer when docked into it. When it fails, it’s yet another Motorola model to be forgotten. Kyocera can try a dual-touchscreen phone. When it fails, Kyocera has scores of other models that will also fail.

When Apple introduces its annual phone, however, it’s a single product, with minor storage, radio and black|white SKU variations. These days, a new iPhone product has to sell 100-200 million units within 12-18 months. There’s no room for (what often seems) frivolous experimentation so prevalent in the industry. No other single product sells in such large numbers.

Follow me

Apple is also unique in constantly moving millions of users into elevated patterns of computing behavior over time. Apple creates markets, others follow. As a market maker, if you will, Apple is in a unique position to create the rules and then educate its users in how to participate in the new paradigm. No other technology company has ever created so many “markets” and educated so many users. Historically, Apple has taught millions how to use GUI-based computers with a mouse. It transitioned personal storage from floppies to hard disk to optical disk to flash. It moved the notion of a cellphone from a device that makes phone calls to a diminutive personal computer with multiple sensors and multi-touch input for hundreds of millions of people. It got millions to pay for music online by the song. It educated people into buying billions of apps instead of using a web browser.

Of course, these new markets have been very good to Apple. But (as I explained four years ago in Why Apple doesn’t do “Concept Products”) with market making comes the responsibility of introducing new technologies with extreme deliberation and the willingness to educate tens of millions of users year after year. There’s no magic to introducing a new OS, for example, when your previous one is deployed by only 7% of your users. In market making, there are no shortcuts.

It may be a dilemma, but it’s not a weakness

The rumor inflated expectations prior to Apple product introductions, followed by the inevitable “let down” has been a familiar leitmotif. Doubled-down secrecy or not, this is unlikely to change in the near future.

But what the pundits may be missing is that Apple is hardly unhappy about this state of affairs. When Steve Jobs said in 2010 that “RIM would have a hard time catching up to Apple because it has been forced to move beyond its area of strength and into unfamiliar territory of trying to become a software platform company,” it was clear that smartphone value proposition had transitioned from hardware to platforms — a clear Apple core competency.

Apple has the best hardware-software-service integration in the industry, bar none. So the fact that the new device wars are now actually fought not on hardware specs but on vertical integration accords Apple a unique advantage. Hardware discipline coupled with constrained SKU count give Apple enormous economies of scale which, in turn, provide depth, reach, staying power, unparalleled gross margins, service excellence and, ultimately, customer loyalty. Counterintuitive as it may seem, rivals may find out that too much hardware “innovation” can actually kill a company. And that is a dilemma.

I’ve been reading “The Innovator’s Solution” recently, and this article resonates well. I totally agree with this view of why Apple is doing so well today.

Things get interesting as we go forward in time. As argued in the Innovator’s Solution, a new innovation comes along and disrupts the market and benefits greatly from integration. However, over time the market starts embracing modularity that allows for innovation in the individual parts.

Apple will have to either continue to put forth new innovations so that their integrated approach continues to win, or they’ll need to embrace the modularity that forms and innovate in parts of the spectrum. (A third option, of course, is to allow themselves to become a niche player…)

Personally, I think we’re early in the cycle still. The iPad is only starting to make the mark it will ultimately make. As you point out, Apple has a great collection of patents that shows that they’re thinking along many different lines. Some of that stuff will eventually make it into shipping products in some form, and Apple will be able to continue to benefit from shipping great products that people want. In the end, that’s what matters.

Great post! I would also add that at many of the inflection points where Apple has come out with massive momentum (iTunes, iPhone), it was the force of Steve Jobs personality that convinced many to go with his “train” or be left at the station. The music labels going with $0.99 or the AT&T boss going with the iPhone sight unseen were fundamental to where Apple is now.

Can Apple still do this? eBooks could be a case study, though I think it is less Apple’s doing and more the DOJ tied in its own underwear.

I’m actually of the opinion that the cause-and-effect works the other way ’round: that Apple seeks out opportunities where it can define a really great product, and that its focus on a deep, coherent feature set for Product X keeps the company too busy to do either a throw-it-at-the-wall Product Y or a me-too Product Z.

An example (in contrasts): Microsoft’s Zune seemingly came out with the same, or even more concentrated SKU focus. But because it was a copycat product, it never resonated with consumers, never defined what a portable music player should be. In the end (and yesterday, it seems, was Zune’s formal end), Zune was an utter waste of management, engineering, marketing and shareholder resources.

As it seems that WinPhone will be, but of a massively greater magnitude. Microsoft, yet again, didn’t ask what new product capability would catch consumers’ fancies, giving them a new ways to be delighted; they are still trying to enter a rather well-defined smartphone marketplace with a some-ways-better, some-ways-not-so list of features.

People credit Apple’s marketing for the hoopla of a new Apple introduction, but Microsoft is a study in muddled messaging that results from not doing the hard work of product definition. For example, WindowsPhone7 was introduced 27 months ago, and only the most educated of consumers could even identify its key features (big colored tiles; reliance on Microsoft’s complex cloud-synch; better Office/Outlook compatibility). And Microsoft has done NOTHING to dismiss most consumers’ sense that Windows is too complex for ordinary people to use; has done nothing to promise WP won’t be stabbed in the cradle the way that Zune and PlaysForSure were; has done almost nothing to promise that users will have compatibility with their friends’ nifty new games or niche apps.

I didn’t mean this to be an anti-Microsoft rant, but I think it’s helpful to understand where, but for the Grace of God and a little help from DNA, Apple could, but does not, go.

Windows Phone’s key features are what is being advertised, so how do you figure that only the most educated of consumers could identify them when they’re promoted so heavily? I do need to point out an inaccuracy in your synopsis though: compatibility with Outlook is not a key feature – there is NO connection between Windows Phone and Outlook.
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I’ve been an iPhone advocate for quite some time. Now that I’ve used Windows Phone, I know that even my dad could use it more effectively than an iPhone. Both operating systems are competitive to one another. I’d even consider carrying both, Windows Phone for work. iPhone for personal.

The problem with relying on hardware specs to differentiate your products is two fold. Firstly, these become generic very quickly (there is little uniqueness for long) and secondly, keeping up forces rapid iteration of devices which as Kontra points out, kills scalability and economy of scale. Ironically, Apple, by building its scale of devices, is in a strong position to soak up new components, leaving niche “cutting edge” components to retailers of low volume, low margin products. Apple is also cautious about reliance on any one supplier or assembler and these people all know this, inc. Samsung. Lastly, rushing to market with bleeding edge technologies usually involves other compromises (LTE chips vs battery life) and reliance on immature software that often undermines the technical specification. Compare the pictures taken with an iPhone with another phone which has higher tech specs and usually the iPhone picture is clearer or better composited than its competitor. Bottom line reiterates the adept drill bit/hole analogy.

Very well thought out. Turning away from a portfolio and toward a tiny number of big bets shuns decades of product and financial theory. This is an essential Apple asymmetry which few dare even to try and none institutionalize.